Why a Psychological Bottom Will Lag Any Real Recovery

Inflation? Deflation? End of the bear? Sucker rallies? Deeper dips yet to come?

The economy will get revving again, and lots of individuals have stayed in the markets "for the long haul." Savvy financial education and experience have taught them that bear markets are choppy, but that recoveries can be breathtakingly huge. "Patience," these people say.

But in reviewing my own retirement savings this year-end, I came to a grim realization. Many, or most, American workers don't even have the principal in their retirement savings anymore. As these workers see their own staggering losses after more than a decade of "saving," they're going to continue bailing on stocks.

I started my IRA in 1997, converted soon thereafter to a Roth IRA, and have generally contributed the maximum allowable. I've tracked my own performance with a ^Ross index starting at 1000. Now that I've socked away nearly $36,000, and with ^Ross closing the year at 2300.87, casual math nets me over $80,000, right?

Wrong. As the IRS upped its contribution limits, the markets also soared to new heights. I contributed most of my money when shares were expensive - when ^Ross was ranging between 3000 and 5000. My principal has earned me only a couple thousand dollars more. I'm one of the luckier ones.

Baby boomers are still holding enormous gains from the '80s and '90s. But they won't be working (or saving) much longer. And my generation has worked most of their adulthood through a lengthy and stealthy bear market.

Most folks don't know this secular bear market is nine years old. The internet changed the world, right? Then we had a good bull run after the dot-bomb and after 9/11, right? Money we put in before this credit crunch has hung in okay, yeah?

Since 1997, the Dow is up 36%. Even the dot-com bubble-laden Nasdaq is up 22% over that period. My retirement savings have still been growing, right?

Wrong again. If you had started an IRA in 1997, had made contributions at the closing price of the S&P 500 index on the first of every month, and had maxed out your IRS contribution limit, you would have lost 22.8% of your principal. That's right - of the $36,000 you put in, you'd have only $27,820 at the end of 2008.

I've got my own odds on the world escaping calamity. (They're not good.) But even if things recover swimmingly, the psychological damage has already been done. The Great Depression generation was still hoarding cash under their mattresses when Ike won the presidency. My generation will take mattresses over markets for years to come.

Equities are not a good long-term holding for now. I've got my cash in gold - the great secular bear parking spot. And I've got my eyes peeled for oversold positions or supply disruptions in commodities markets. Oil fills that bill now.

Disclosure: Author holds long positions in DGP and DXO

Comments

[Prudent Man...:]

I have no problem with this analysis but it failed to state that if he hadn't gone to a Roth IRA, which I never thought was that good of an idea as I don't have that much confidence in markets, he would have made substantial saving in income taxes.

Also, it is silly to put all of your retirement money in stocks. If he was a sound investor he would have put some of that money in fixed income. If he was a good investor he wouldn't have bought an index but picked stocks.

I back-tested my social security payments and if I had put 50% S & P 500 and 50% Treasury Bills, I would receive over $8,000 per month. If my deductions for social security were tax deductible, like and IRA I can't imagine how much I would be receiving today. I passed this info on to the Administration but never received a reply as there are many individuals out their where this would be true.

The Social Security Administration average 1.5% annual rate of return. How do they do that when they have been investing for decades in Treasury Bills yielding over 3% until the past decade?

The Social Security Administration's "Ponzi" make Madoff look like a piker.

Jan 01 09:59 AM

[PeakOiler:]

PrudentMan, you say the SS Admin is a 'Ponzi' scheme, and it is, but it has nothing to do with the body of your comment. It's a Ponzi scheme because the money coming out to recipients is being funded by the money coming in from contributors. The biggest Ponzi scheme in the history of the world, indeed.

You seem to be complaining about how you could be receiving $8000 per month if you had invested your contributions, rather than what, about $1500 per month now under SS. I am sure your $8000 is a good estimate since you are a CFA. But Social Security was set up so that those who don't contribute as much as you (and other higher income folks) can receive enough in retirement to eek out a marginal existence. That's not the Ponzi part, that's the socialist part, and I see nothing wrong with it. I prefer not to have my ancient parents living with me as I go thru middle age. Not only that, but hindsight is always perfect, and if the next twenty years is anything like the last two, we'll all be happy to have a modest, but steady Social Security income in old age.

Jan 01 10:21 AM

[Greg Pinelli:]

PeakOiler is correct..and for every CFA who'd be getting 8 grand a month I know 5 deadheads who'd have to go on the public dole because they lost whatever they had.....
I'm not a great fan of Social Security and it's probably not best to start a new year with the depressing thought of how it will be paid for..but..there simply are not enough people who are self directed enough to handle retirement any longer....
If anyone needs an object lesson on how dependent and helpless the American people have become look at Hurricane Katrina..I STILL hear whining every week from groups who think govt didn't do enough!
As for the authors oil and gold...couldn't be more correct. Gold alone will probably be a portfolio saver for many in the next few years.


On Jan 01 10:21 AM PeakOiler wrote:

> PrudentMan, you say the SS Admin is a 'Ponzi' scheme, and it is,
> but it has nothing to do with the body of your comment. It's a
> Ponzi scheme because the money coming out to recipients is being
> funded by the money coming in from contributors. The biggest Ponzi
> scheme in the history of the world, indeed.
>
> You seem to be complaining about how you could be receiving $8000
> per month if you had invested your contributions, rather than what,
> about $1500 per month now under SS. I am sure your $8000 is a good
> estimate since you are a CFA. But Social Security was set up so
> that those who don't contribute as much as you (and other higher
> income folks) can receive enough in retirement to eek out a marginal
> existence. That's not the Ponzi part, that's the socialist part,
> and I see nothing wrong with it. I prefer not to have my ancient
> parents living with me as I go thru middle age. Not only that, but
> hindsight is always perfect, and if the next twenty years is anything
> like the last two, we'll all be happy to have a modest, but steady
> Social Security income in old age.

Jan 01 11:04 AM

[Jimbo:]

There is one aspect that the posters on this thread are overlooking. The Social Security System also pays modest stipends to disabled and mentally retarded folks, as well as certain people with chronic mental illness. I have no beef with this because many of these people would be in very dire straits otherwise. But what rots my socks is that this enormous welfare system is NOT paid into by government employees such as members of Congress, Congressional employees and, yes, employees of the Social Security System: "We have our Own retirement system"!! As far as I am aware, only the military, of all federal employees, pay into Social Security. Congress has traditionally screwed, blued, and tatooed the rest of the populace. Congress has exempted itself from OSHA, the Civil Rights Act of 1964, etc. They just gave themselves another stealth pay raise the other day. I believe it was Mark Twain who observed that Congress was the only original criminal class to emerge in the U.S.

Jan 01 01:24 PM

[Urbane Gori...:]

Thanks for the article. My personal feeling is that people like Bogle and Templeton are bigger criminals than Bernie Madoff. As they push to maintain their funds, the average person has gotten nailed in ways that put Madoff's little scheme to shame. Yet they show up on the tube telling people to 'average in' and 'not to worry as the market always pays off over time.'.

Can I also gripe about old Larry 'Goldilocks-mustard seed' Kudlow as well? What the heck do mustard seeds have to do with the market? Where does he get those weird clothes? And does he ever stop to take a breath, or let anyone else finish a sentence?

jegan

Jan 01 02:22 PM

[The Rebel:]

If I had a long position in DXO and had held it most of the way down, I'd have psychological problems, too. Don't know how long you have held your position.

Jan 01 02:37 PM

[mkreisel:]

If oil drops by 50% or more in any given month, DXO goes to zero immediately. If the oil bleeds to 25 over next few months, DXO will be zero and dissolved like DCR back in July. It doesn't matter if oil goes to 200 sometime in next years, once wiped out, your investment is not going to come back.

I'm bullish on oil in general, but I will never, ever 'invest' in scams such as DXO, SSO, SDS, SKF, FXP, or FAZ.

Jan 01 06:42 PM

[Moon Kil Woong:]

To be bearish on commodities and looking for a blow-up in them and then by gold is a bit contrarian isn't it? I understand to watch commodities to see when to get out of goldbug mode makes sense. But the author seems to indicate he isn't watching it for that reason. Last I knew gold was a commodity as well.

Jan 01 08:04 PM

[gordon:]

You're taking too much risk in gold because Paulson has smacked it every time near $900, all he does is make 2 phone calls, the IMF to sell gold, and the Goldman Sachs Commodities Index Boyz, to underweight/manipulate gold. If you followed the 80-week moving average on the $SPX you would have got out of the market, just like you say the break to the upside in early 2003, plot a weekly chart, use a 52-week moving average if you like. In 2007, the $SPX needed to get above 1435 or it was doomed. Read the chart.
3-month FDIC CDs 2.5%-3.5% laddered, TIPS, if you bought them in the last couple yrs, I still have some yielding over 6%, bank CDs(Imperial Capital is good locally here in San Diego, yea, they have troubles, but they're FDIC paying 4% now), I recently bought GEGlobal bonds paying 7% thru 2011, FirstEnergy paying 7.5% thru 2012, both non-callable, AA- BBB area, all these alternatives would have keep you sleeping at night.
Better start listing to Phil Grande too (philsgang.com) before you trade-away the rest of your money.

Jan 01 08:28 PM

[M dub:]

Ross, good article. You're right, everyone under 40, maybe 50 is underwater in their 401k. Those people who are laid off with credit card debt may throw up their arms and cash out.

More importantly the boomers have pretty much only ever known a bull market for their whole investing lifetime. I haven't seen a bum rush for the door where everyone is yelling "i'm gettin out while there is still something left". Is it still to come?

Indeed there is a lot of hope on all that is being thrown into the kitchen sink in of monetary and fiscal policy.

Jan 01 08:32 PM

[auto44:]

Sabatage you say?????????????????


On Jan 01 08:28 PM gordon wrote:

> You're taking too much risk in gold because Paulson has smacked it
> every time near $900, all he does is make 2 phone calls, the IMF
> to sell gold, and the Goldman Sachs Commodities Index Boyz, to underweight/manipulate
> gold. If you followed the 80-week moving average on the $SPX you
> would have got out of the market, just like you say the break to
> the upside in early 2003, plot a weekly chart, use a 52-week moving
> average if you like. In 2007, the $SPX needed to get above 1435 or
> it was doomed. Read the chart.
> 3-month FDIC CDs 2.5%-3.5% laddered, TIPS, if you bought them in
> the last couple yrs, I still have some yielding over 6%, bank CDs(Imperial
> Capital is good locally here in San Diego, yea, they have troubles,
> but they're FDIC paying 4% now), I recently bought GEGlobal bonds
> paying 7% thru 2011, FirstEnergy paying 7.5% thru 2012, both non-callable,
> AA- BBB area, all these alternatives would have keep you sleeping
> at night.
> Better start listing to Phil Grande too (philsgang.com) before you
> trade-away the rest of your money.

Jan 02 12:33 AM

[Ross Snyder:]

I was glad to see PrudentMan steer the conversation to Social Security. For the bottom 2/3 of American wage earners, Social Security is their last defense against eating ramen and working at Wal-Mart past age 80. If IRA's and 401(k)'s are truly underwater for folks 20 years or less away from retirement, the system will change. Sure, the money will run out. But politically, until we start electing congressmen willing to lose elections in order to help the country, benefits will not go away.

Nevertheless, this credit crisis is making it easier for folks to consider change. I'm working on another article on tax code changes, and Social Security is Ground Zero for a needed change.

For those responding to my personal basket of oil and gold double long ETFs: I can't imagine holding a commodity other than gold more than a month in this market. It's too volatile. I'm in oil while expecting shorts to cover and supply cuts to finally register with folks. (People discounting peak oil theory reminds me of people discounting global warming.) And yes, gold is a commodity, and I've certainly been burned by the overall monetary deflation. But the short interest is immense, individual demand will be strong for years, and at some level it will function as a currency vis a vis exchange rates.

It's hard to say that gold supply will decrease (due to increased sovereign reserves and greater individual holdings), monetary supply will increase, but gold prices won't rise. In the event of deflation, all of this central bank monopoly money has to go somewhere. In the event of inflation, gold should rise as a traditional hedge against it.

Jan 02 02:48 AM

[Smarty_Pants:]

"Sure, the money will run out. But ... benefits will not go away." - Ross Snyder


The $64 Trillion question is, "What can you buy with those benefits"?

If 'the money' runs out, then the printing presses (or digital equivalent) will have to fill the gap and simultaneously devaluing the dollar.

Sure, the social security check will show up every month but will everyone be satisfied with the sandwich and cup of coffee it will buy?

Jan 02 11:44 AM

[1977°C:]

I am very sorry for your Gold and Crude Oil investments you are heading into 2009, on the other side if Gold will decline to 450-500 $ an ounce and Oil will be 15-21 $ a barrel then this 2 investments will have sense as most of the stocks in SP 500,RUSSELL 2000,WILSHIRE 5000 indexes will be down by the same amount in percentage, so all in all Oil and Gold will be just OK.

Jan 02 12:17 PM

[Freedoms Truth:]

"Equities are not a good long-term holding for now. "

Buying now beats buying at S&P 1400!
I am way off my highs, but also off my lows, up 30% from november in one account. I did it by buying stocks that are at incredible sale prices, under 0.5 book, low single digit PE, etc. This only happens in a super-bear. I guess I should feel lucky that one account is dead even with where it was 8 years ago, since the market was higher then.

It was a mistake to be all in at the top and a mistake to be all out now.

If all the market does is go sideways for 2009, I'll be okay on my divvie stocks like PFE.

All this bearishness warms my heart, makes me realize that the market will have plenty of upside once people realize its not so bad. I think 2009 will be an up year in the 15-20% range, clsoe around 10500 on the dow.

Jan 02 05:50 PM

[prudentinve...:]

Good article.

People who put in equal amounts each month are victims of the mainstream media and charlatans who've sold them the "buy stocks at all times" mantra. They've even gone as far as convincing people that market timing is bad, and that stocks always go up, regardless of how expensive they are when they buy them.

People need to take charge of their own savings. Stocks are great investments when purchased at the right price and held long-term. I've been in the market for thirty years, and have only bought stocks when their price seemed reasonable. Which means little or no buying during bubbles, no matter how hard the sell, and no matter how bad the alternative of cash at near-zero rates. I've avoided significant purchases 1996-2000 and 2005-2007 and have bought heavily 1990-94 and 2002-2004. I've bough selectively in 2008, but still expect good or even better values in 2009. As a result, I have no complaints and no regrets about stocks, and wish the same for all who read this. Just remember not to get carried away by the hype and to look for real value P/E<10, Yield>4%, reasonable business prospects, and reasonable balance sheets, and above all, ignore the bandwagons and the hype.

If you feel you must buy mutual funds and not individual stocks, then I'd suggest you try to buy them during market downturns and minimize pouring money in during periods of irrational exuberance.

Good luck for 2009.

Jan 03 04:19 PM